If your company has travel and entertainment costs, there's a way to pay for them without resulting in income to your employees or payroll taxes for the company. It's called an "accountable plan" and it is a reimbursement arrangement for the costs your employees pay for their business travel, entertainment, and other costs on behalf of the company.
Tax results for an accountable plan
An accountable plan is best understood by looking at what happens if you don't have one. Say you have a sales person who travels and wines and dines customers. Her annual travel and entertainment (T&E) costs are $2,500, which she lays out and is then reimbursed by the company under a non-accountable plan. The results:
- The reimbursement is treated as income to her, which must be included on her W-2 form.
- She can claim a deduction for her T&E costs, but only as a miscellaneous itemized deduction on Schedule A of Form 1040, which means she has to itemize her deductions instead of claiming the standard deduction. Miscellaneous expenses are only deductible to the extent they exceed 2% of adjusted gross income. She must complete Form 2106 to figure the deductible portion of these costs before entering them as a miscellaneous itemized deduction.
- If she's subject to the alternative minimum tax, she loses any benefit from her itemized deductions; miscellaneous itemized deductions are not a subtraction for purposes of this tax.
- The company must pay payroll taxes on the reimbursement. Payroll taxes include the employer share of FICA, as well as federal unemployment taxes (FUTA) and state unemployment insurance. Also, such amounts are subject to income tax withholding for federal and, where applicable, state purposes.
What is an accountable plan?
An accountable plan lets the company claim a deduction for the T&E costs reimbursed to the employee to the extent such costs are deductible. There's no income to the employee or any payroll taxes for the company on these reimbursements.
Requirements for an accountable plan
To be an accountable plan, all three of the following conditions must be met:
1. Business connection: The expenses must have a business connection. Expenses incurred by an employee while doing his or her job usually have such a connection. Reimbursements of personal expenses, such as commuting costs or a spouse's travel costs, do not meet this business connection condition.
2. Proper substantiation: The employee must adequately account to the company for expenses within a reasonable time (generally within 60 days after incurring the expense). Adequate accounting means completing expense reports (written or online) and providing the company with receipts, invoices, and other documentary evidence of the expense. For example, accounting for business lunches means following the "4 Ws+1H": who did the employee dine with, what was the business purpose of the meal, where did the meal take place, when did the meal take place, and how much did it cost. In addition, a receipt for the meal or the charge card statement is the documentary evidence needed here.
3. Return of excess reimbursement: The employee cannot keep unused advances and must return to the company any excess reimbursements within a reasonable time. There are two ways to determine reasonable time:
- Fixed date requires advances to be made no earlier than 30 days before the expense, substantiation made within 60 days of the expense, and excess reimbursements returned to the company within 120 days after the expense.
- Periodic statement requires the company to give employees statements at least quarterly, showing substantiated amounts and requiring employee to substantiate other amounts or return any excess reimbursements.
If the company uses an accountable plan but the employee fails to comply with these conditions, then reimbursements to this employee are treated as paid under a nonaccountable plan. In other words, the whole plan isn't disregarded, but this particular employee suffers the consequences of failing to meet all conditions (and the company owes employment taxes on the reimbursements that are income to the employee).
While the tax law does not require an accountable plan to be in writing, it is a very good idea to do so. A written plan given to employees lays out the substantiation requirements and times in which action must be taken. It's up to the company, not the employee, to create an accountable plan; an employee cannot simply convert reimbursements to accountable plan status by providing substantiation to the company and following other accountable plan rules. It is advisable for corporations to include accountable plans in their official records; corporate shareholders can vote them in a resolution and include them in corporate minutes.
Details about accountable plans can be found in IRS Publication 463, Travel, Entertainment, Gift, and Car Expenses.
What else you need to know
Accountable reimbursement plans aren't limited to travel and entertainment costs. They have been used successfully to reimburse employees for tools and equipment, training and certification if required for the job, and other business-related costs (e.g., dues to professional organizations, subscriptions to trade and professional journals, and work clothes required for the job).
Some tax experts have suggested that accountable plans can be used to reimburse employees for home office deduction costs if the arrangement is undertaken for the convenience of the company; there have been no cases or rulings on this point.
Companies can avoid the need for reimbursement arrangements by furnishing employees with corporate credit cards to be used solely on company business. Employees in this case will still need to substantiate their expenses to the company on expense account forms or by other means, but reimbursements aren't necessary here.
A final word of caution: The IRS looks for abuses in accountable plans, such as treating all reimbursements as paid under an accountable plan when some reimbursements may not qualify for this treatment (e.g., reimbursements for meals to employees who work late). Talk to your tax professional about how you can use an accountable plan in your company to minimize your payroll taxes.
Barbara Weltman is an attorney, prolific author with such titles as J.K. Lasser’s Small Business Taxes and The Complete Idiot’s Guide to Starting a Home-Based Business, and trusted professional advocate for small businesses and entrepreneurs. She is also the publisher of Idea of the Day® and monthly e-newsletter Big Ideas for Small Business® at www.barbaraweltman.com and host of Build Your Business radio. Follow her on Twitter at BarbaraWeltman.